GAO Study

The Dodd-Frank Act mandated that the GAO conduct a study regarding the “accredited investor” standard in order to understand whether the existing criteria serves the intended purpose or whether alternative criteria should be considered. The report was recently released and can be accessed here: http://gao.gov/products/GAO-13-640?source=ra. In addition to reviewing data, the GAO conducted interviews with market participants.

In connection with the SEC’s proposal to relax the ban on general solicitation released in August 2012, various commenters expressed their concern that the “accredited investor” standard should be reviewed, especially if general solicitation and general advertising were to be permitted in connection with private offerings. Again, more recently, in connection with the SEC’s open meeting to approve final rules to amend Rule 506, an SEC Commissioner urged the SEC to review the “accredited investor” standard. The SEC’s proposal regarding private offerings seeks comment on the standard.

In connection with its study, the GAO considered whether there should be an investments owned criterion added to the standard, or a tiered approach that would limit investments to a fixed percentage of an individual’s net worth (this sounds similar to the approach used in connection with crowdfunded investments under Title III of the JOBS Act). The GAO also considered whether the standard should be modified to introduce a sophistication or financial literacy prong. In its report, the GAO notes that market participants seemed to consider a minimum investments owned criterion as practicable.

This is not the first time that the standard has been under consideration. For example, in 2007, when the SEC considered amendments to Regulation D, it had considered a new category of larger accredited investors. Of course, more recently, in 2010, the Dodd-Frank Act modified the definition slightly and also required that the SEC revisit and review the standard at least every four years. In light of the considerable debate regarding the appropriate balance between facilitating capital formation and protecting investors, it is reasonable to expect that the accredited investor standard will be revised soon.

The JOBS Act directed the GAO to undertake a study concerning the factors impeding greater use of currently Regulation A. The GAO study examines trends in Regulation A offerings, noting that the number of offerings increased from 1992 through 1997. This increase followed the SEC’s changes to the offering ceiling for Regulation A offerings from $1.5 million to $5 million. Since 1997, however, the number of Regulation A offerings has declined. The study notes that issuers have tended to favor Regulation D offerings. The report cites a number of factors that likely have contributed to the lack of interest in using Regulation A for capital-raising. For example, the report cites the delays associated with the SEC review of Regulation A offering statements (whereas an issuer faces no disclosure requirements in connection with a Regulation 506 offering made to accredited investors) and, of course, the time-consuming and expensive process for complying with state securities laws. The report details a number of significant advantages associated with Regulation D offerings.

The report does lead one to consider the relative attractiveness of various offering alternatives.

For example, if an issuer (not a reporting company) is prepared to make its offering available only to (verified) accredited investors, the issuer soon will be able to solicit and will not have specific disclosure requirements. Of course, the securities sold in the Rule 506 Regulation D offering will be restricted. No limit on dollars that can be raised.

If the issuer completes one or many such offerings, provided it stays below the new 12g threshold, it will not be required to furnish periodic information to the SEC.

An issuer that is not a reporting company might undertake crowdfunding offerings, through a funding portal or a broker-dealer, to investors meeting certain standards, but then the issuer must comply with certain disclosure requirements in connection with the offering, and also be subject to ongoing albeit limited information requirements. The securities sold in the crowdfunding offering will be restricted. The dollar amounts are small.

Under the JOBS Act, in conjunction with the new Regulation A+ or 3(b)(2), the SEC has discretion to require that the offering document contain audited financials, and that the issuer subsequently make periodic disclosures. Will new 3(b)(2) be appealing? What are the trade-offs for an issuer? If the issuer wants to avoid the costs associated with state blue sky review, then the issuer will either contemporaneously list its securities on a national exchange, or sell to “qualified purchasers.” We don’t yet know who would be classified as a qualified purchaser. The issuer could generally solicit. The issuer will have to comply with specific disclosure requirements in connection with the offering, and, in addition, it will have ongoing disclosure requirements. Of course, the securities sold will not be restricted securities. Is it worth it? Well, the answer to this question will depend largely on the approach taken by the SEC in its rulemaking on 3(b)(2). Will some consideration being given to the fact that there was widespread support for amending Regulation A, even before the JOBS Act had materialized? Will the SEC conduct some cost/benefit analysis and appreciate that if new 3(b)(2) is made sufficiently burdensome it will not provide the useful capital raising alternative that Congress and others had envisioned for emerging companies. Let’s assume the SEC will exercise its discretion to require some additional disclosures. At least, it would make sense to put a premium on clear, concise disclosure, which would be meaningful to investors.

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